With the economy in a constant state of struggle and foreclosures and unemployment numbers on the rise, credit is a hot-button issue these days. Whether you want to buy a new car or rent an apartment, your credit score can help lenders determine how attractive you are as a borrower. The problem is, many of us don't know how our credit scores are calculated or how we may be damaging them.
To help, here is a list of the most common ways that people end up hurting their credit scores inadvertently and how you can avoid them:
DON'T avoid credit altogether. If you avoid credit cards and loans altogether, your credit score will stay perfect, right? Wrong. Having little or no credit can be a detriment to your credit score. The whole point of a credit score is to show that you know how to handle credit. If you have no credit, there is no way for lenders to know if you can deal with debt.
DO apply for different types of credit. Avoiding different kinds of credit can also hurt your credit score, such as only having one credit card and no loans or mortgages, or only having school loans and no credit cards. The best way to make sure you are maximizing your credit score is to keep a diverse amount of credit in your credit portfolio, as well as making sure you are paying all of your bills on time.
DON'T lower your credit limits or close out accounts. It seems like it would make financial sense to lower your credit limits or cancel credit cards so that you aren't tempted to spend money. The problem is that doing so can hurt your credit. Here's how: One of the main factors of your credit score is your "credit utilization ratio," which measures your limit-to-balance ratio on your credit cards. As the ratio goes up, your credit score is likely to be negatively affected. Say your total credit limit is $10,000 and your total balance is $1,000. Your credit utilization ratio would be 10 percent. If you cut your credit limit to $5,000, but your balance remains $1,000, your ratio is now 20 percent. A higher credit utilization ratio is considered a negative factor because it means that you are using more of your credit limit.
DON'T hold on to "good" debt. It's a common myth that holding on to a little bit of debt can actually help your credit score. However, the total amount of debt that you owe, along with your credit utilization ratio, is a big factor in calculating your credit score. This not only hurts your credit score, but it can also rack up extra fees that you don't need to pay. Bottom line, the less money you owe, the better.
DO check your credit score regularly. Even if you follow all the rules of good credit, things outside of your control can affect your credit score. Lenders can make mistakes. Your identity could be stolen and credit could be opened in your name. If you are not regularly monitoring your credit score, these mishaps can drag down your score without you knowing. It's a good idea to check your scores at least once a year, or a few months before you think you might apply for a loan or line of credit. Consider a credit monitoring service if you want to regularly keep tabs on your credit.
While all of these factors contribute to your score, always remember to follow the golden rule of credit: pay your bills on time. Avoiding late payments, collections, foreclosures, evictions or any other major default will keep your credit score healthy. Your payment history is a big part of your score, so keep it clean and don't take on more debt than you can handle.
Jeff Hindenach started his career as a journalist for the San Jose Mercury News and the San Francisco Examiner. He is currently the Director of Content for NextAdvisor.com, a leading consumer and small business information web site. He specializes in credit monitoring, legal services and security software.